LLC Growth 2025

LLC Conversions & Growth 2025

Navigating the tax minefield of "Deemed Transactions": From adding new partners to converting for venture capital.

Executive Summary

The flexibility of the LLC is its greatest strength and its most dangerous trap. Unlike C Corporations, simple changes in an LLC's ownership structure trigger complex "deemed" tax events.

Adding a partner to a single-member LLC can be treated as a taxable sale of assets or a tax-free contribution, depending entirely on how the funds flow (Rev. Rul. 99-5). Granting equity to employees (Profits Interests) requires precise valuation to avoid immediate income tax. Finally, converting to a C Corp for IPO requires the "Assets Over" method to secure QSBS eligibility.

New Members

Sale vs. Contribution: Selling interest to a new partner triggers gain for the founder. Contributing cash to the LLC is tax-free but creates 704(c) complexity.

Service Partners

Profits Interests: The "Carried Interest" model allows tax-free equity grants if liquidation value is $0. Requires 83(b) election.

Conversion

To C Corp: Use the "Assets Over" method (Rev. Rul. 84-111) to ensure stock qualifies for the 100% QSBS exclusion.

Adding Members (Rev. Rul. 99-5)

The "Deemed" Fiction

When a Single-Member LLC (Disregarded Entity) becomes a Multi-Member LLC (Partnership), the IRS pretends the old entity vanished and a new one was born.

Situation 1: Purchase Interest

Money goes to Owner

  • Fiction: Owner sells 50% of assets to New Member.
  • Result: Immediate Gain Recognition for Founder.
  • Benefit: Buyer gets "Step-Up" in asset basis.

Situation 2: Contribution

Money goes to LLC

  • Fiction: Founder contributes assets; New Member contributes cash.
  • Result: Tax-Free (Section 721).
  • Trap: Assets have "Carryover Basis." Triggers 704(c) allocations.

Service Partners & Profits Interests

Giving equity for services is dangerous. A "Capital Interest" is taxable immediately as wages. A "Profits Interest" is not.

The "Liquidation Value" Test

Capital Interest

If the LLC liquidated TODAY, this partner would get cash.

Taxable: FMV of interest is Ordinary Income immediately.

Profits Interest

If the LLC liquidated TODAY, this partner would get $0.

Tax-Free: Safe Harbor (Rev. Proc. 93-27). Only participates in future growth.
Pro Tip: Always file a Section 83(b) Election within 30 days of grant, even for Profits Interests. It costs $0 tax now but protects against massive tax if the IRS recharacterizes it later.

704(c) Allocations: Book vs. Tax

When a partner contributes appreciated property (Sit. 2), the "Book" value is high, but "Tax" basis is low. Section 704(c) fixes this disparity.
Method Impact on Founder (Contributor) Impact on Investor (Non-Contributor)
Traditional Gain Deferred May lose depreciation deductions (Ceiling Rule).
Curative Accelerated Income Full deductions (stolen from Founder).
Remedial Phantom Income Created Guaranteed full deductions (creates notional items).

Converting to C Corp

Usually done for IPO or VC funding. The method matters for QSBS (Section 1202) eligibility.

Assets Over

LLC contributes assets to Corp -> LLC liquidates distributing stock.

QSBS Eligible? YES. (Gold Standard)

Interests Up

Partners contribute LLC interests to Corp.

QSBS Eligible? RISKY. (Corp receives "interests," not assets).

Interactive: LLC Structuring Wizard

Select your growth scenario to see the tax consequences and recommended structure.

Scenario Details

Select an event to see analysis.

Tax Impact Analysis

Immediate Tax --
Basis Impact --
Critical Requirement --